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Production Sharing Agreements in Putin's Russia

Every so often a company signs an agreement so advantageous it becomes part of corporate lore and is analyzed in business school textbooks for years to come. In 1994, a consortium of foreign oil companies known as the Sakhalin Energy Investment Corporation (SEIC) believed it had signed just such a deal with the Russian government for the development rights to the Sakhalin-2 oil and gas fields in the Russian Far East (RFE).

SEIC’s former CEO Steven McVeigh claimed in a Harvard Business School case study that the production sharing agreement (PSA) for Sakhalin-2 included the 'best PSA terms that you will ever get in Russia'.1 Twelve years later, Russian President Vladimir Putin summoned the CEOs of SEIC’s remaining partners - Shell, Mitsui and Mitsubishi -to the Kremlin and forced them to sell a controlling stake in Sakhalin-2 to Gazprom, Russia’s state-owned gas company.

The changing balance of power in corporate-government relations over Sakhalin-2 indicates how the dynamics of the Russian energy industry have changed in the past fifteen years. In the 1990s, Russia was weak and oil prices were low. In order to stimulate foreign investment in geographically isolated and technologically complex hydrocarbon projects, the Russian government signed three PSAs with major international oil companies (IOCs) between 1994 and 1995. The French company Total manages the Kharyaga PSA in the Timan-Pechora basin and the U.S. corporation ExxonMobil operates the Sakhalin-1 PSA in the RFE. The Anglo-Dutch conglomerate Royal Dutch/Shell led the Sakhalin-2 project until Gazprom joined the PSA in late 2006. Although the PSA projects vary in size, cost and production, they rank among the largest foreign investments in Russia and each is strategically significant in its own right.

Under Putin, the Russian government has reasserted its control over the commanding heights of the economy by restricting private and foreign investment in strategic sectors, particularly energy. The Putin administration’s actions towards the PSA operators are often cited as evidence of Russia’s resurgent resource nationalism. However, an examination of the corporate-government relations surrounding Kharyaga, Sakhalin-1 and Sakhalin-2 from 2000 through September 2007 reveals important differences in the government’s approach towards each project. How can we explain this variation in behaviour? Is there a strategic purpose behind the Kremlin’s actions towards the projects or are they simply a series of tactical manouevres?

The Putin administration’s behaviour towards Kharyaga, Sakhalin-1 and Sakhalin-2 can be explained by a combination of operational, consortium, regional, industrial, technological, legal and geopolitical factors unique to each PSA project. The government has refrained from aggressively intervening against Kharyaga or Sakhalin-1 because forces within the Kremlin have yet to reach a consensus on the strategic direction of either project. In the case of Sakhalin-2, the Putin administration established a long-term vision for the project in accordance with its regional and strategic interests. The government then took systematic and decisive action to alter the project’s management and ownership structure and bring it under the Kremlin’s control.

The existing literature on Russian energy policy describes the PSA projects within the context of industrial dynamics and corporate strategy or analyzes the projects in isolation.2 Until now there has been no consolidated, comparative study of the Putin administration’s behaviour towards Kharyaga, Sakhalin-1 and Sakhalin-2. Identifying and analyzing the factors that have shaped the government’s approach towards these strategically important projects provides insight into the Putin administration’s energy strategy, the competitive dynamics of the Russian energy i